Tax Accounting: Property Transactions - Wash Sales, 30-Day Rule, Disallowed Loss, Basis Adjustment

? What this actually is

A wash sale occurs when you sell a security at a loss and then repurchase the same or substantially identical security within 30 days before or after the sale. The loss from this sale is disallowed for tax purposes. This matters because it affects your taxable income and the basis of your investments, which can impact your tax liability. The core idea is that you can't claim a loss on the sale of a security if you buy it back too soon.

? The core logic (or formula)

1. 30-Day Rule: The wash sale rule applies to purchases made within 30 days before or after the sale.
2. Disallowed Loss: The loss from the wash sale is not deductible in the current tax year.
3. Basis Adjustment: The disallowed loss is added to the basis of the repurchased security.
4. Substantially Identical: The rule applies to securities that are the same or substantially identical.
5. IRA Transactions: Wash sale rules also apply to Individual Retirement Accounts (IRAs).

? Hidden rule nobody explains

In practice, the wash sale rule can be tricky when dealing with multiple lots of the same security. If you sell one lot at a loss and repurchase another lot within the 30-day window, the disallowed loss must be allocated proportionally to the repurchased lots. This can complicate basis tracking and future gain/loss calculations.

? Practical example / breakdown

Let's say you bought 100 shares of XYZ Corp for $50 per share on January 1st. On February 1st, you sell all 100 shares for $40 per share, realizing a loss of $1,000. However, on February 10th, you repurchase 100 shares of XYZ Corp for $45 per share.

1. Identify the Wash Sale: The repurchase on February 10th is within 30 days of the February 1st sale, triggering the wash sale rule.
2. Disallowed Loss: The $1,000 loss from the February 1st sale is disallowed.
3. Basis Adjustment: The basis of the repurchased shares is increased by the disallowed loss.
4. Original basis of repurchased shares: $4,500 (100 shares * $45)
5. Adjusted basis: $4,500 + $1,000 = $5,500

? Your move today

Goal: Practice identifying and calculating the impact of a wash sale.

Step-by-step:
1. Open a spreadsheet or a piece of paper.
2. List a hypothetical security purchase and sale with dates and prices.
3. Identify if a wash sale occurs based on the 30-day rule.
4. Calculate the disallowed loss.
5. Adjust the basis of the repurchased security.

What to save: A completed example showing the purchase, sale, disallowed loss, and adjusted basis.

? Quick reference asset

Wash Sale Cheat Sheet

Common mistakes & recovery

• Common Error 1: Forgetting to adjust the basis of the repurchased security.
• Recovery: Always add the disallowed loss to the basis of the new security.
• Common Error 2: Not recognizing substantially identical securities.
• Recovery: Be aware of securities that are effectively the same, even if they have different names or slight variations.
• Quick Check: Verify that the basis of the repurchased security includes the disallowed loss.
• Exam Tip: On exams, carefully read the dates of transactions to spot wash sales quickly.

? Completion check

I can identify a wash sale, calculate the disallowed loss, and adjust the basis of the repurchased security correctly.